Capitalization of Income

Capitalization of IncomeCapitalization of income valuation method places no value on fixed assets such as equipment, and takes into account a greater number of intangibles. This valuation method is best used for non-asset intensive businesses such as service companies. “Cap Rates” can be derived from various methodology. One such valuation method is the build-up method where IBBOTSON ASSOCIATES statistical data is used from publicly traded companies. Other cap rates are derived from Industry Rules of Thumb and market sales.

In his book “The Complete Guide to Buying a Business” (Amazon, 1994), Richard Snowden cites a dozen factors that should be considered when using Capitalization of Income Valuation. He recommends giving each factor a rating of 0-5, with 5 being the most positive score. The average of these factors will be the “capitalization rate” which is multiplied by the Seller’s discretionary cash to determine the market value of the business.

The factors are:

  • Owner’s reason for selling
  • Length of time the company has been in business
  • Length of time current owner has owned the business
  • Degree of risk
  • Profitability
  • Location
  • Growth history
  • Competition
  • Entry barriers
  • Future potential for the industry
  • Customer base
  • Technology